The Tax Foundation is the nation’s leading independent tax policy nonprofit. Since 1937, our principled research, insightful analysis, and engaged experts have informed smarter tax policy at the federal, state, and global levels. For over 80 years, our goal has remained the same: to improve lives through tax policies that lead to greater economic growth and opportunity.

Trade-offs of Delaying Tax Filing and Instituting a Payroll Tax Holiday on Businesses and Individuals

April 9, 2020

Taylor LaJoie

Taylor LaJoie

Some policymakers are proposing a payroll tax holiday for businesses and individuals for 2020 and a complete delay in filing deadlines for tax year 2019 and 2020 to April 2021. Businesses could also delay their quarterly estimated payments in 2020 to April 2021.

Suspending the payroll tax on both employers and employees would reduce the payroll tax rate to zero. Importantly, individuals would still have federal and state income taxes withheld from their paychecks, but payroll taxes would not be owed by employers or employees for the remainder of the 2020 tax year.

Here are the pros and cons.

Advantages

Helps businesses to maintain payroll (employee retention). One of the major components of the CARES Act, the Paycheck Protection Program, is designed to help employers retain workers by providing forgivable loans to businesses for up to eight weeks of certain payroll expenses. Likewise, the CARES Act delayed employer-side payroll tax obligations to ease cash flow constraints on businesses, and the IRS delayed Quarter 1 estimated payments. Taking the same principle, deferring all quarterly estimated tax payments until next April would provide businesses with more cash on hand to pay employee salaries and maintain payroll.

In the same vein, a wholesale payroll tax suspension may support firms facing liquidity problems and considering layoffs, slowing the economic slowdown.

Allows individuals to keep more of their paycheck (increased purchasing power to the taxpayer). If businesses are not required to withhold and remit employee-side payroll taxes on each paycheck, employees are able to keep more of their money and spend it on essentials, including groceries and medical supplies, which in turn relieves hospitals and social services to assist the most vulnerable.

May stimulate aggregate demand. The economic effect of the payroll tax holiday depends on which side of the tax is reduced. Reductions in the employer-side of the payroll tax may have larger economic effects than reducing employee’s payroll taxes, though the latter also stimulates aggregate demand. This is more important for the recovery phase of the economy in the aftermath of mitigating the public health crisis.

Disadvantages

Increase the deficit. Instituting a payroll tax holiday on employers and employees reduces federal revenues and increases the deficit (revenues minus expenses). We recently estimated that a payroll tax holiday on employers and employees for the remainder of the year would add hundreds of billions to the deficit. The CARES Act adds $2 trillion to the deficit on top of the previously projected $1 trillion deficit for 2020. Increasing the annual deficit not only adds to the national debt, which now exceeds $22 trillion, but makes it more difficult for the U.S. to repay its obligations and meet future fiscal shortfalls and challenges.

Temporary payroll tax reductions have a mixed record. Payroll tax holidays have a mixed economic record, repeating the problems that plague temporary tax policy more broadly. A payroll tax suspension may not be the most effective tool for responding to a growing economic downturn. In 2010, Congress lowered the payroll tax from 6.2 to 4.2 percent to stimulate the economy for 2011 and 2012. The economic evidence suggests the tax holiday was mostly saved by households, reducing the effectiveness of the holiday as an economic stimulus.

A payroll tax suspension for the remainder of the year is primarily a way to give money out to businesses and those who are still employed rather than stimulate aggregate demand or boost employment. Households would more than likely save that money or pay off debts and other expenses. Instead of being an economic stimulus payroll tax reductions help firms in need of liquidity make it through the crisis.

Unemployed workers would not benefit. While a payroll tax holiday could boost the incomes of those who are still receiving paychecks, those who are already out of work would not see any benefit. This makes a payroll tax suspension not well targeted as a tool for economic relief.

Trust Fund considerations: Payroll taxes support the Social Security and Medicare trust funds. If payroll taxes were suspended, lawmakers would need to find a way to replenish the trust funds to make up for the lost revenue. Suspending the payroll tax also creates a greater precedent for future payroll tax suspensions and transfers from the general fund to cover entitlement benefits, undercutting the program’s design.

Conclusion

Policymakers should remember that taxes affect behavior. Deferring tax filing and payments will help employers and employees have more liquidity during the crisis, and though such delays will increase the deficit now, the long-term effect is negligible as these taxes will eventually be recouped by the government.

A complete suspension of payroll taxes would boost incomes by reducing taxes paid. However, this would reduce government revenue that directly funds benefit programs. Further, payroll tax suspensions have not historically been an effective way to boost aggregate demand during a crisis and we should not expect a suspension amid the crisis to boost hiring. Additionally, a payroll tax suspension is not the most effective policy decision at this time since it doesn’t address workers who are already laid off and collecting unemployment insurance. These trade-offs should be kept in mind as policymakers debate the best policies to support businesses and individuals.

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The Tax Foundation is the nation’s leading independent tax policy nonprofit. Since 1937, our principled research, insightful analysis, and engaged experts have informed smarter tax policy at the federal, state, and global levels. For over 80 years, our goal has remained the same: to improve lives through tax policies that lead to greater economic growth and opportunity.